The Impact of High Inflation on Your Investment Portfolio

high inflation

The Bureau of Labor Statistics’ Consumer Price Index for December reported a 7.0% year-over-year increase. This is the largest 12-month increase in prices since 1982 and follows a 6.8% increase in November. Inflation makes most people quite nervous, understandably. It affects people in every economic bracket, and investing in a high inflation environment can be a significant challenge for the average investor.   

Inflation Is a Real Threat to Economic Well-Being

When prices rise, individual purchasing power is diminished as goods and services become out of reach for many. Inflation is not always bad. It can stimulate job growth, but rising costs on inputs like gasoline or lumber affect company profits. Many businesses will struggle to offer their products at affordable prices. Companies will often choose to lay off employees or limit hiring as a temporary measure. The impact to workers’ standard of living can be considerable, especially if elevated inflation is sustained over a longer period of time. 

Effect of Inflation on Investment Portfolios

There is more than enough historical data on the effects of Inflation that it’s possible to see a pattern of how it affects people’s investments and their investment strategies. For investors, inflation is a stealth threat to their savings, bonds, and investment returns. The rate of return has to outpace inflation by a significant percentage for the investor to get any return at all. 

Fixed income securities suffer the most in an inflationary economy. In a normal economy, many investors favor income-generating stocks or stocks that pay dividends because they provide a reliable income stream. In an inflationary economy, these are less attractive investments because they tend to not keep up with inflation levels. 

There are some assets that rise in price with inflation, including equities over the long term and commodities. Value stocks perform better than growth stocks in periods of high inflation. 

Investors tend to view the stock market as providing some protection against inflation, but research has shown that stock market returns are the lowest during periods of high inflation. Historically, stock market returns have been best when inflation is between 2-3%.

2022: More Inflation Ahead

The trend for the next few months at least would seem to indicate more inflation. According to the November 2021 Survey of Consumer Expectations (SCE) conducted by the Federal Reserve Bank of New York, consumers believe that inflation will remain at 6% throughout 2022 and stay as high as 4% over the upcoming three-year period.

Despite higher prices, demand for consumer goods remains high. Supply shortages in the commodities, housing, and automobile industries have persisted for months or years, and are still present, but people continue to buy despite the sticker shock.

Potential Federal Reserve Responses

It’s very likely that the Federal Reserve will raise interest rates in March of 2022 for the first time since December of 2018. At a recent hearing before the Senate Banking committee, Federal Reserve Chair Jerome Powell stated, “If we see inflation persisting at high levels, longer than expected, if we have to raise interest rates more over time, then we will.” This will discourage borrowing and decrease the money supply, subduing inflation, perhaps as soon as the second quarter. 

For investors, an inflationary economy is frustrating, anxiety provoking, and confusing. Inflation affects investments across the board, and it can be difficult to make wise decisions about how to invest in the short and longer term. If you have questions about your investment strategies and how they will be impacted by inflation, Strategies Wealth Advisors is here to help advise you on how to create an all-weather investment portfolio that will work to mitigate risk in a variety of scenarios, including a high-inflation environment. 

 

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